Description

China Mobile 

Six years ago I wrote up SAIC Motor, a Chinese SOE, and made some valuation comparisons to Buffett’s purchase of PetroChina in 2002.  Six years ago there was a lot of skepticism about Chinese SOEs, just like there is today, but ultimately every asset has a value and some values are way too cheap.  At the time, SAIC was trading for 3.5 times earnings ex-cash, 6.5x earnings with cash, 8% dividend yield.  It was just too cheap.  Very quickly, the stock doubled. 

Six years later, I see another opportunity in another Chinese SOE.  After years of share price declines, the market is offering the dominant #1 Chinese telco (62% mobile service revenue market share, 37% EBITDA margin vs. 28-30% of peers) at a 1.7x (!) EV/EBITDA, 5x P/E ex-cash (8x P/E with cash), and 7% dividend yield.  It’s just too cheap. 

While the $60 bn of net cash (45% of $133 bn market cap) may or may not be immediately accessible (the company pays dividends out of earnings, not accumulated net cash), the 7% dividend yield certainly is, and is 350 bps above the China government 10-year bond yield vs. a long-term average spread of 40 bps. 

China Mobile didn’t used to be this cheap; in mid-2017 for example the stock traded for 4x EV/EBITDA (vs. 1.7x today) and 3% dividend yield.  Since then, NTM EBITDA estimates are up 8% whereas the stock is down 42%. 

What happened?  The obvious culprit is 5G and worries about the 5G capex cycle.  The headline sounds scary (is the Chinese government pushing for uneconomic 5G investment at the expense of the carriers?!) but the reality is really quite benign.  2020 is a big 5G capex year, but 2020 capex guidance came in well below market expectations at 180 bn RMB, only +8% y/y (and no, not because of covid – 1H20 capex of 101 bn will actually be much higher than 2H20 capex of 79 bn).  Why?  Two main reasons:

·       4G and other legacy capex fell dramatically, more than anticipated

·       Per-base station construction costs came in much lower than expected (so no, the government is not artificially directing funds to Huawei via the carriers).  The company was able to increase its new base station guidance 20% this year from 250k to 300k while coming in at a capex envelope lower than expected.  This is also a positive sign for capex in future years.

China Mobile had been planning to use 2.6 GHz as the center of its 5G build, but in May this year it signed a deal with CBN (China Broadcasting Network, another SOE) to share & build a joint 5G network in the 700 MHz band.  Being able to use 700 MHz, a better propagating frequency, significantly reduces densification and rural coverage requirements.  This is another factor that should reduce capex over time. 

Management talks about 2020-2022 as being the peak of 5G investment, but comments that the three years would be roughly similar with maybe small increases vs. 2020 capex.  With revenue growth and capex decline starting in 2023, current capex levels of 26-27% of service revenue should fall back to the low 20s levels prior to the next upgrade cycle.   

The other concern with China Mobile is with competition.  4G ARPUs fell significantly from initial launch prices, and viewed on a per-GB usage basis, pricing completely collapsed.  Will the same thing happen in 5G? 

I think it’s reasonable to expect 5G ARPUs to eventually fall from initial launch levels, but I don’t think the same scenario as in 4G will repeat. 

·       In 4G the other two operators, Telecom and Unicom, were trying to aggressively catch up on mobile market share and as a result competed very aggressively, especially because China Mobile had a head start in 4G.  This time, all three players are starting at the same time, and there is a network sharing deal between Telecom and Unicom.  So far, the 5G prices of all three operators are nearly identical. 

·       In 4G the government wanted to encourage consumption of data and bring data prices to a low enough level to be affordable to all, as well as eliminate consumer-unfriendly charges like roaming.  This has already been accomplished, and as a result there is less of a need to bring such pressure to 5G.  At 48 RMB per month (down 28% from 2013 levels), China Mobile’s ARPU is less than two cups of Starbucks coffee. 

In short, there is nothing on the horizon that suggests serious challenges for the company.  The 7% dividend yield is a real number that we should expect at a minimum to be maintained if not (more likely) increased over time.  The valuation should converge to more historical type levels. 

Catalyst

Dividend yield being too high; valulation converging toward historical levels as the business remains stable then grows EBITDA due to upgrade to 5G.